Aldergate Traders: profitable but overdrawn
Aldergate Traders is negotiating banking facilities for January to March. December sales were £36,000. Budgeted sales are January £40,000, February £46,000 and March £52,000. Half of each month's sales are for cash and half on credit, collected in the month after sale. Goods are bought a month ahead, so purchases in each month equal 60% of the following month's sales and are paid for in the month after purchase. Wages and overheads of £9,000 a month are paid as incurred. A £30,000 machine will be paid for in February, and a £15,000 tax bill falls due in March. The opening cash balance on 1 January is £8,000. The bank has offered a £25,000 overdraft facility. The finance director says the business is 'comfortably profitable' and cannot see why the bank wants a cash forecast.
1. Prepare the cash budget for January to March and identify the peak financing requirement.
Read the worked answer
Receipts (50% cash in month + 50% of previous month's sales):
- Jan: 20,000 + 18,000 = £38,000
- Feb: 23,000 + 20,000 = £43,000
- Mar: 26,000 + 23,000 = £49,000
Payments (purchases = 60% of the following month's sales, paid the next month):
- Jan: Dec purchases (60% × 40,000) 24,000 + 9,000 = £33,000
- Feb: Jan purchases (60% × 46,000) 27,600 + 9,000 + 30,000 machine = £66,600
- Mar: Feb purchases (60% × 52,000) 31,200 + 9,000 + 15,000 tax = £55,200
| Jan | Feb | Mar | |
|---|---|---|---|
| Opening balance | 8,000 | 13,000 | (10,600) |
| Receipts | 38,000 | 43,000 | 49,000 |
| Payments | (33,000) | (66,600) | (55,200) |
| Closing balance | 13,000 | (10,600) | (16,800) |
The business moves into overdraft in February and the peak requirement is £16,800 at the end of March. That is inside the £25,000 facility, but headroom is only £8,200 - about six days of payments.
2. Recompute the position if credit customers take one month longer to pay, and advise the board.
Read the worked answer
If credit receipts are one month late, January receives cash sales only and December's credit sales arrive in February:
- Jan receipts: 20,000
- Feb receipts: 23,000 + 18,000 = 41,000
- Mar receipts: 26,000 + 20,000 = 46,000
| Jan | Feb | Mar | |
|---|---|---|---|
| Opening | 8,000 | (5,000) | (30,600) |
| Receipts | 20,000 | 41,000 | 46,000 |
| Payments | (33,000) | (66,600) | (55,200) |
| Closing | (5,000) | (30,600) | (39,800) |
The facility is breached in February (£30,600 against £25,000) and the requirement reaches almost £40,000. The base budget is therefore not robust: a one-month deterioration in debtor days - entirely normal - breaks the facility.
Advice: negotiate a £45,000 facility, or agree with the bank that the machine is bought on lease/hire purchase or paid in instalments; time the tax payment; tighten credit control; and consider stretching supplier payment terms, since the firm already pays a month after purchase. A cash-flow forecast, reviewed monthly with a sensitivity, is essential - the £8,200 headroom is not real comfort.
3. Explain why a profitable business needs an overdraft, and identify the items that separate profit from cash here.
Read the worked answer
Profit is earned when a sale is made; cash arrives when the customer pays. In the quarter Aldergate will record roughly £138,000 of sales and a healthy margin, yet cash is absorbed by:
- Debtor growth - a month's credit sales are always outstanding, and the balance grows as sales grow from £36,000 to £52,000.
- Buying a month ahead - purchases run at 60% of the next month's sales, so cash leaves before the related sale, and rising sales mean rising stock and rising payments.
- The machine (£30,000) - capital expenditure is not a cost in the profit and loss account (only depreciation is charged), but the cash leaves in full in February.
- The tax bill (£15,000) - relates to past profit already earned; it is a cash event, not this quarter's expense.
So profit measures performance; cash measures survival. The board should be shown a cash budget alongside the profit forecast, since the business can be profitable and still fail on timing.